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Weekday Trader

Seeing Forest Labs Through the Trees

By

Johanna Bennett

Updated Oct. 20, 2004 11:59 p.m. ET

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HOW THE MIGHTY HAVE FALLEN!

Shares of Forest Laboratories hit an all-time high of 78.81 on March 1, after climbing nearly sevenfold over five years.

But since then, the stock has plunged more than 44%, badly lagging the Standard & Poor's 500 Index, as investors worried about the slowing market for antidepressants and the imminent arrival of cheaper generic versions of Celexa, Forest's old blockbuster antidepressant (see Weekday Trader, "Forest Labs Is Still In The Woods," October 13, 2003).

But fortunes sometimes change for the better. At 43.88, Forest is just 6.7% off its 52-week low, reflecting investors' worst fears -- and maybe presenting a buying opportunity.

"Wall Street is missing the earnings power of this company," says Brian Clifford, a portfolio manager with SunAmerica who recently bought more shares.

At a Glance: Forest Laboratories (FRX)

Stock Price:

$43.88

52-Wk High:

$78.81

52-Wk Low:

$41.10

Market Cap:

$16.3 billion

Earnings Est. (FY 2005):

$2.74

FY 2006 P/E:

16.1x

Projected Long-term EPS Growth Rate:

20%

Projected EPS Growth (FY'04/'05):

40.5%

Sales (FY '04):

$2.68 billion

Div. Yield:

None

CEO:

Howard Solomon

Headquarters:

New York, NY

Sources: Thomson First Call; Reuters.com

On Monday Forest raised its financial guidance for the fiscal year ending March 31, 2005 after beating Wall Street's earnings expectations, due in part to sales of its newer antidepressant Lexapro.

Forest's management seems confident that generic competition won't harm Lexapro's sales. A solid balance sheet with plenty of cash should give it a strong financial cushion. And licensing deals could help fill out Forest's pipeline.

Meanwhile, the stock's valuation is the cheapest in a decade.

Best known for its superior sales force, Forest relies on licensing deals with foreign companies for many of its products, including Celexa.

Celexa, which generated about 41% of Forest's revenues in fiscal 2004, saw its patent expire in January 2004. That allowed generic drug makers to file with government regulators for permission to sell cheaper knockoffs in the U.S.

Forest is counting on sales of Lexapro, high-blood-pressure drug Benicar and the Alzheimer's drug Namenda to offset the revenues it could lose from Celexa next year. It already has hiked Celexa's price and encouraged doctors to begin prescribing Lexapro instead.

Some investors have worried that managed care companies will force Lexapro patients to pay more out of pocket for the drug once generic versions of Celexa are available.

But in a recent investors' conference call, Forest's president and chief operating officer Kenneth Goodman claimed that while many health plans will lower the co-payments for generic Celexa, "key plans" will leave Lexapro's co-payment unchanged.

"The issue isn't how fast Celexa vanishes but how fast Lexapro grows," says David Steinberg, an analyst with Deutsche Bank.

Celexa's sales have been falling, though more slowly than expected. And despite the U.S. Food and Drug Administration's new warning that antidepressants can trigger suicidal behavior in children, Lexapro's sales soared 78% to $415 million in the three quarters that ended September 30.

"Celexa is a big product. Forest probably can't negate it all. But they are doing an admirable job of getting [Lexapro] up there," says David Heupel, portfolio manager for the Thrivent Large Cap Growth Fund.

Part of a class of antidepressants known as selective serotonin reuptake inhibitors (SSRIs) because they balance serotonin levels in the brain, Celexa and Lexapro compete against
Eli Lilly's
Cymbalta; its older Prozac;
Wyeth's
Effexor, and
GlaxoSmithKline's
Wellbutrin.

The number of prescriptions doctors wrote for Lexapro soared by more than 50% in September over the previous September, capturing a robust 18.8% of the market. That far outpaced the tepid 1.3% growth in prescriptions for the group as a whole.

"If you look past generic Celexa, this is a growth story," says Steinberg.

Meanwhile, a healthy balance sheet, no debt and $2.58 billion in cash and marketable securities gives Forest the flexibility to bolster shareholder value or invest in the company's growth.

Although Morgan Stanley estimates fiscal 2006 profits could be flat, earnings should grow by an average of 20% annually over the next three to five years, according to Thomson Baseline

"As long as they can feed the distribution with more products, they should continue delivering a profitable business model," says SunAmerica's Clifford.

And shares of Forest look cheap, trading at 17.7x projected profits over the next four quarters. That's a bit more than half its five-year median 34.7x forward earnings, according to Baseline.

The stock fetches a 10% premium to the S&P 500 and a group of drug stocks tracked by Baseline. That's way below its 50% premium to the industry and 70% premium to the market over the last five years.

Of course, Forest's investors would be melancholic if generic versions of Celexa hit the U.S. market sooner than expected; if patients abandon Lexapro for cheaper generic medications, or if sales growth of Namenda and Benicar falter.

Wall Street also is awaiting the results of a patent fight with rival Ivax over Lexapro. It goes to trial next spring.

But as Forest's marketing machine kicks Lexapro's sales into high gear, as the company moves to license more new drugs and as Wall Street begins to notice how cheap this stock really is, investors in Forest may lose their blues and start raking in the green again.

FULL DISCLOSURE:

Lehman Brothers rates shares of Forest at "Overweight," according to Richard Silver, an analyst. The firm does not have an investment banking relationship with the company. Silver does not own the stock.

Deutsche Bank rates Forest at "Buy," according to David Steinberg, an analyst. The firm does not have an investment-banking relationship with Forest. Steinberg does not own the stock.

Punk Ziegel & Co. rates Forest Laboratories at "Buy," says David Lickrish, an analyst. The firm does not have a banking relationship with Forest. Lickrish says he does not own the stock.

According to a disclosure from Morgan Stanley, the firm rates Forest at "Overweight." The firm has received compensation for investment banking services from Forest within the last 12 months and expects to receive or intends to seek compensation in the next three months. Analyst Marc Goodman does not own the stock.

SunAmerica Asset Management has purchased shares of Forest Laboratories in the last three months, according to Brian Clifford, portfolio manager. As of June 30, the firm held over 205,000 shares, according to Streetsight.net, a financial Web site.

Thrivent Financial has sold shares of Forest in the last three months, says David Heupel, portfolio manager. As of June 30, the firm held over 680,000 shares, according to Streetsight.net.

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